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Spending on outpatient prescription drugs in Medicaid--the joint federal-state program that finances medical services for certain low-income adults and children--has accounted for a substantial and growing share of Medicaid expenditures. Medicaid's total spending on outpatient prescription drugs grew from $4.6 billion in fiscal year 1990 to $40 billion in fiscal year 2004--or from 7.0 to 14.2 percent of Medicaid's total expenditures for medical care. State Medicaid programs do not directly purchase prescription drugs; instead, they reimburse retail pharmacies for covered outpatient prescription drugs dispensed to Medicaid beneficiaries. For some outpatient multiple-source prescription drugs, state Medicaid programs may only receive federal matching funds for reimbursements up to a maximum amount known as a federal upper limit (FUL). Required by law as a cost-containment strategy, FULs are calculated as 150 percent of the lowest price for a drug, from among the prices published nationally in three drug pricing compendia. State Medicaid programs have the authority to determine their own reimbursements to retail pharmacies6 for covered outpatient multiple-source prescription drugs, as long as those reimbursements do not exceed established FULs in the aggregate. The Deficit Reduction Act of 2005 (DRA) included provisions that changed the methodology for calculating FULs. Beginning January 1, 2007, a drug's FUL will be based on the average manufacturer price (AMP). The Congressional Budget Office estimated that when implemented, AMP-based FULs could reduce total Medicaid spending for prescription drugs by $3.6 billion from 2007 to 2010 and by about $11.8 billion from 2007 to 2015. Though representing a potential cost saving measure for Medicaid, the change in FUL calculation methodology--using AMP instead of the lowest published price--has raised concerns among retail pharmacies serving Medicaid beneficiaries. Because of interest in the potential effects of the AMP-based FULs on retail pharmacies, information was requested on how AMP-based FULs will compare with retail pharmacy acquisition costs. GAO estimated what the AMP-based FULs would have been if they had applied in 2006 and compared them with average retail pharmacy acquisition costs from 2006 for frequently used and high expenditure multiple-source outpatient prescription drugs in Medicaid.

The AMP-based FULs we estimated using AMP data from first quarter 2006 were lower than average retail pharmacy acquisition costs from the same period for 59 of the 77 drugs in our sample. For our entire sample of 77 multiple-source outpatient prescription drugs, we found that these estimated AMP-based FULs were, on average, 36 percent lower than average retail pharmacy acquisition costs for the first quarter of 2006. The extent to which the AMP-based FULs were lower than average retail pharmacy acquisition costs differed for high expenditure drugs compared with the frequently used drugs and the drugs that overlapped both categories. Though the difference between AMP-based FULs and retail pharmacy acquisition costs was in some cases sizable, the extent of this difference may change because of several factors, including the quarter-to-quarter variation in AMPs used to set FULs as well as the presence of rebates that retail pharmacies may obtain from drug manufacturers and wholesalers. To the extent that the utilization of multiple-source outpatient prescription drugs by retail pharmacies remains similar in 2007 and later to the utilization patterns captured in our sample of drugs for the first quarter of 2006, the gap between estimated first quarter 2006 AMP-based FULs and pharmacy acquisition costs could persist, once the AMP-based FULs are implemented in 2007. In reviewing a draft of this report, CMS disagreed with our finding that the AMP-based FULs were lower than the average retail pharmacy acquisition costs for most of the 77 drugs in our sample. In particular, CMS had significant concerns with our estimates of both pharmacy acquisition costs and AMP-based FULs and stated that our findings had not accounted for changes in these two variables that are likely to take place after DRA provisions are implemented in January 2007. In the draft report we identified the limitations of the data sources used in the estimates and acknowledged that the difference between retail pharmacy acquisition costs and AMP-based FULs could change following implementation of DRA provisions in 2007. Only after AMP-based FULs are implemented in 2007 will there be an opportunity to determine the extent to which these FULs facilitate both cost-effective Medicaid drug expenditures and adequate reimbursement for retail pharmacies.